Introduction to Econometrics

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Introduction to Econometrics

• Lecture 8
• Autocorrelation

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Econometric problems
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Topics to be covered

• Overview of autocorrelation
• First-order autocorrelation and the Durbin-Watson
  test
• Higher-order autocorrelation and the
  Breusch-Godfrey test
• Dealing with autocorrelation
• Examples and practical illustrations

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Autocorrelated series and autocorrelated
disturbances
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Overview of autocorrelation
What is meant by autocorrelation The error terms
are not independent from observation to
observation ut depends on one or more past
values of u What are its consequences? The least
squares estimators are no longer efficient
(i.e. they dont have the lowest variance). More
seriously autocorrelation may be a symptom of
model misspecification How can you detect the
problem? Plot the residuals against time or their
own lagged values, calculate the
Durbin-Watson statistic or use some other tests
of autocorrelation such as the Breusch-Godfrey
test How can you remedy the problem? Consider
possible model re-specification of the model a
different functional form, missing variables,
lags etc. If all else fails you could correct
for autocorrelation by using the Cochrane-Orcutt
procedure or Autoregressive Least Squares
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First-order autocorrelation
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The sources of autocorrelation
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The consequences of autocorrelation
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Detecting autocorrelation
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The Durbin-Watson test
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More on the Durbin-Watson statistic
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Using the Durbin-Watson statistic
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Durbin-Watson critical values
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The Breusch-Godfrey (LM) test
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The Breusch-Godfrey test continued
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Dealing with autocorrelation

• How should you deal with a problem of
  autocorrelation?
• Consider possible re-specification of the model
• a different functional form,
• the inclusion of additional explanatory
  variables,
• the inclusion of lagged variables (independent
  and dependent)
• If all else fails you can correct for
  autocorrelation by using the Cochrane-Orcutt
  procedure or Autoregressive Least Squares